Who Qualifies for an IRA?
REGULAR IRA
Generally, taxpayers without pension plans can deduct an Individual Retirement Account
(IRA) contribution if both spouses are employed (or self-employed). Effective
1/1/02,each can make
deductible contributions up to $3,000 to an IRA. And even if your spouse isn't employed,
both of you can have IRAs, putting away a total of $6,000 each year - but no more than
$3,000 in either IRA.
Guidelines for taxpayers with pension plans are more technical. If you or your spouse are
active participants in an employer's pension plan, your IRA contributions may be fully
deductible for 2002 if your adjusted gross income is under $35,000 if single or under
$55,000 if married, filing jointly.
Effective 1/1/02, taxpayers who have attained age 50 in any applicable tax year may ay additional "catch up" contributions
ROTH IRA
Taxpayers of any age who have earned income are eligible to make a non deductible
contribution of $3,000 (new 2002 limit) (reduced by any regular IRA contributions). Eligibility is
phased out (i.e.: the $3,000 contribution limit is lowered) for taxpayers with incomes
above certain limits. These are as follows; single taxpayers with AGI between
$95,000 and $110,000 and for joint filers with AGI between $150,000 and $160,000.
Questions and Answers About IRAS & ROTH IRAS
The Taxpayer Relief Act of 1997 expanded eligibility for Individual Retirement
Annuities (IRAs) and created a new choice - the Roth IRA. As a result, IRAs are now
available to more people. To help you sort through the new options and choices, review the
most frequently asked questions and answers about IRAs.
Question:
Did the Taxpayer Relief Act of 1997 eliminate traditional deductible and nondeductible
IRAs?
Answer: No. In fact, the Taxpayer Relief Act of 1997 actually
expands the eligibility requirements for traditional IRAs. Effective for tax-year
2002,
the adjusted gross income (AGI) threshold is increased to $35,000 for
single taxpayers and $55,000 for married taxpayers. Over the next ten years, the income
caps will gradually increase to $50,000 for single taxpayers and $80,000 for married
taxpayers.
Question: Did the Taxpayer Relief Act of 1997 result in other
changes to traditional deductible and nondeductible IRAs?
Answer: Yes. Beginning in 1998, participation in a qualified
plan by one spouse does not affect the IRA deduction of the other spouse unless the
couple's AGI exceeds $150,000. The deduction is totally phased out at $160,000.
Furthermore, the legislation provides new exceptions to the 10% early withdrawal penalty
on early IRA distributions. For distributions after 1997, no 10% penalty tax will apply if
the taxpayer uses such amounts to pay for qualified education expenses or certain
first-time home buyer costs (up to $10,000).
Question: How does the new Roth IRA work?
Answer: Individuals make non-deductible IRA contributions of up to $3,000 per year, and
generally receive tax-free distributions. They may withdraw nondeductible contributions
tax-free at any time. The distribution of earnings is tax-free if the individual has
participated in the Roth IRA for at least five years and the distribution meets one of the
following qualifications:
- used to buy a first home (up to $10,000)
- made to a beneficiary after the individual's death
- attributable to the individual becoming disabled o received after age 59 1/2
Question:
What are the eligibility requirements for a Roth IRA?
Answer: Taxpayers of any age who have earned income are eligible
to contribute. Eligibility is phased out for single taxpayers with AGI between $95,000 and
$110,000 and for joint filers with AGI between $150,000 and $160,000. Individuals and
couples in the phase-out range may make smaller contributions.
Question: Can a participant in an employer-sponsored retirement
plan, including SEPs, SIMPLEs, 401(k), etc., make contributions to a Roth IRA?
Answer: Yes, provided the individual qualifies under the
adjusted gross income requirement.
Question: How much can be contributed annually to a Roth IRA?
Answer: Effective 1/1/02, contributions are limited to
$3,000 (single) and $6,000
(joint) and they cannot exceed 100% of aggregate earned income. As long as one spouse
holds a job, non-working spouses will be eligible to contribute up to $3,000.
Contributions may continue beyond age 701/2, as long as the individual has earned income.
Question: How much of the Roth IRA contribution is deductible?
Answer: None of the contribution is tax deductible.
Question: When can individuals begin making contributions to a
Roth IRA?
Answer: Roth IRAs were available beginning January 1, 1998.
Question: Can contributions be made to both a Roth and a
traditional IRA?
Answer: Yes, however combined contributions made to Roth and
traditional IRAs cannot exceed the annual $3,000 (single '02 limit) or $6,000
(joint '02 limit) contribution
limit. In addition to nondeductible cash contributions, individuals may convert (transfer)
assets from a traditional IRA to a Roth IRA.
Question: Should a client choose a traditional or Roth IRA?
Answer: Base each decision on your individual retirement
planning needs and circumstances. The table below shows that individuals expecting their
tax rate to either remain the same or increase by the time the money is withdrawn will
benefit from the Roth IRA. However, if their tax rate drops significantly when the money
is withdrawn, they may be better off with a deductible IRA. Keep in mind that due to
expanded eligibility requirements, many more taxpayers will qualify for the Roth IRA than
a traditional (deductible) IRA. Furthermore, in most situations it is unlikely that
individuals will be in a lower tax bracket when the money is withdrawn.
| Theoretical Value | Theoretical Value | Theoretical Value | |
| Type Of IRA | Year 5 | Year 10 | Year 20 |
| Roth IRA | $12,672 | $31,291 | $98,846 |
| Traditional IRA | |||
| 15% Tax Rate | $14,316 | $34,316 | $105,252 |
| 28% Tax Rate | $12,447 | $30,249 | $92,402 |
| 31% Tax Rate | $12,067 | $29,310 | $89,437 |
Assumptions used in arriving at above values. For illustrative purposes only. Figures will vary should assumption change.
 |
$2,000 annual contribution for years 5, 10, and 20. |
|
8% annual return |
|
28% tax bracket when contribution is made and in each year until withdrawn |
|
Contributions beginning of year, withdrawals end of year |
|
Traditional (deductible) IRA balances assume tax savings ($560 per year) are reinvested in a taxable account with earnings taxed each year. The taxable account is combined with the IRA balance upon withdrawal. |
|
No tax penalty upon withdrawal |
This chart is used to
illustrate a comparison of the accounts and is for illustrative purposes only. Based
on current tax law, distributions may need to be taken over a period of years rather than
in a lump sum to accomplish the tax bracket reflected.
Question:
Question: Can anyone convert a traditional IRA to a Roth IRA?
Answer: Households with adjusted gross income (AGI) below
$100,000 could have begun converting their existing traditional IRAs to the new Roth IRA
in 1998. (Married taxpayers who file separately cannot take advantage of this conversion
provision.) For purposes of determining conversion eligibility, the balance converted is
not added to AGI.
Question: What are the tax implications associated with
converting an existing traditional IRA to a Roth IRA?
Answer: Individuals converting a traditional IRA to a Roth IRA,
will owe ordinary income taxes on the converted earnings and deductible contributions.
However, if the conversion was made before January 1, 1999, the income may be spread over
a four-year period. If the IRA was converted after December 31, 1998, all taxes owed must
be paid in the year of conversion. The 10% early withdrawal penalty does not apply to
conversions.
Question: If individuals convert a traditional IRA to a Roth
IRA, can they continue to make annual IRA contributions?
Answer:Amounts converted to a Roth IRA are added
to income, therefore it may affect an individual's annual IRA eligibility to make
contributions and/or take deductions.
Question: Can proceeds from a 401(k), profit sharing, or pension
plan be rolled over to a Roth IRA?
Answer: Further guidance is needed from the IRS to find a clear
answer to this question. Currently, the rules suggest direct conversions from qualified
plans are not authorized. Therefore, individuals with a qualified plan distributions would
need to roll over into a traditional IRA, then convert to a Roth IRA.
Question: Can proceeds from a SEP be rolled over to a Roth IRA?
Answer: This is not specifically addressed in the legislation.
However, it seems possible to first roll proceeds to a rollover IRA and then convert to a
Roth IRA. Caution: It is our belief that a technical correction will be forthcoming
regarding some of these unclear issues. This is one area we anticipate receiving
attention.
Question: When are individuals required to take withdrawals from
a Roth IRA?
Answer: Traditional IRA minimum distribution rules are not
applicable to a Roth IRA until after the owner's death. Roth IRA owners are not required
to take any distributions during their lifetime. As a result, converting to a Roth IRA
will provide individuals with a lifetime of unlimited tax-free accumulation and perhaps
tax-free accumulation following their death for their beneficiaries. Distributions are
tax-free to beneficiaries and subject to normal post-death distribution requirements. This
provision offers the potential for decades of additional tax deferral beyond that offered
by traditional IRAs.
Question: How are withdrawals from a Roth IRA taxed?
Answer: Withdrawals are tax-free at anytime, if they do not
exceed the amounts contributed. Distributions from a Roth IRA are made on a first-in,
first-out (FIFO) basis. Withdrawals taken in excess of contribution amounts (earnings) are
taxed as ordinary income. All withdrawals (including earnings) are tax-free if taken after
five years and meet any one of the following criteria:
Attainment of age 59 1/2
Death
Disability
First-time home purchase (up to $10,000)
Question:
How are premature withdrawals (nonqualified distributions) penalized?
Answer: Withdrawals exceeding contributions (earnings) taken
prior to age 591/2 are subject to a 10% IRS-imposed penalty, unless one of the following
conditions is met:
Death
Disability
Catastrophic medical expenses to pay for health insurance premiums after extended unemployment
Substantially equal payments for life
Post-secondary education expenses
Rolled to another IRA in a timely manner (60 days)
First-time home purchase (up to $10,000)
Question: Should individuals convert traditional IRAs to Roth
IRAs?
Answer: Maybe. Maybe not. Converting requires individuals to pay
income tax on the distribution from the traditional IRA. Whether the long-term benefits of
the Roth IRA will outweigh the immediate income-tax bite of conversion depends on a number
of factors. Analyze and consider such factors as life stage, income, current and projected
tax brackets, anticipated rate of return and the amount currently invested in
tax-deductible IRAs. Individual situations can become complicated very quickly. A few
simple guidelines may be helpful:
| Generally, converting will be more advantageous the further the client is from retirement and the higher the expected rate of return - the client may accumulate more tax-free earnings! |
| Clients in high tax brackets with large amounts of tax-deferred earnings in existing IRAs, may pay considerable taxes upon conversion. In this scenario, conversion may not be advantageous for clients closer to retirement. |
| On the other hand, even if your client is nearing retirement, converting to a Roth IRA may be a smart move. Converting may be in the client's best interest because Roth IRAs allow for contributions past age 701/2 and do not require minimum distributions. The Roth IRA may allow the client to continue experiencing tax-deferral advantages and pass tax-free income to heirs. |
Question:
How should clients pay the income tax associated with converting?
Answer: Clients converting a traditional IRA to a Roth IRA, are
almost always better off paying the income tax from other savings rather than from the
existing IRA. By paying the taxes separately, the money will continue to grow and the
client will benefit from higher tax-free earnings.
Question: Can converted funds be commingled with ongoing Roth
IRA contributions?
Answer: All traditional IRA funds converted to a Roth IRA must
be segregated from ongoing contributions. For clients wishing to both convert and make
additional Roth IRA contributions, a separate contract must be established for each.
Furthermore, separate contracts must be established for multiple conversions.
The SEP
Alternative
Many business owners hesitate to establish a retirement plan because they think it's too
complex and expensive. However, in a limited number of cases a Simplified Employee Pension
(SEP) plan may be the answer for you.
A SEP is a simple way to increase retirement savings for both you and your employees while
reducing your business's tax bill. With a SEP, you gain these benefits:
| Easy to establish. You simply complete a SEP plan document, and eligible employees establish a SEP Individual Retirement Account (IRA) at the financial institution of their choice. |
| No complex plan document. A SEP is a simple program. |
| No employee booklets. A signed copy of the plan is the agreement you give to eligible employees. |
| No government filings. You don't need to file the plan with the IRS or the Department of Labor. |
| Simple contribution allocation. You may contribute the same percentage of compensation for each participating employee based on a written allocation formula. Ease of administration means less expense compared to other qualified retirement plans. |
| No year-end signing deadline. You may establish a plan as late as your tax filing deadline with extensions to qualify for a prior-year tax deduction. |
| Ease of administration means less expense compared to other qualified retirement plans. |
There are however disadvantages to a SEP. These are as follows:
| All contributions are immediately 100 percent vested. |
| All Employees who have the required service and earn over $400 (part time also) are covered |
| Simplified formula may lead to a larger cost for "rank & file" employee contributions |
| 15% of "covered compensation" deduction limit |
| Subject to "Top Heavy" minimum contribution requirements. |
| The extent to which assets are protected from creditors are not as great as in a qualified Plan |
| Information regarding the contribution must be provided to all participants. |
Like other qualified retirement plans, SEP contributions are currently tax-deductible, and both contributions and earnings grow tax-deferred. Participants aren't taxed until they withdraw the funds. Usually this is at retirement when they may be in a lower income tax bracket. So...under certain circumstances.....A SEP may be the answer
